Citigroup will pay Fannie Mae $968 million to compensate the taxpayer-backed mortgage buyer for more than a decade of claims tied to faulty home loans.

The agreement includes 3.7 million mortgages originated from 2000 to 2012 and sold to Fannie Mae, New York-based Citigroup said today in a statement. While payments are covered by existing reserves, the company set aside an additional $245 million in the second quarter.

Banks including Citigroup and Bank of America Corp. have been pressed to buy back flawed mortgages as Fannie Mae and Freddie Mac seek cash to repay the $187.5 billion bailout they received after the 2008 financial crisis. The two U.S.-owned firms rank among the biggest buyers of home loans, and banks typically promise refunds if the mortgages lack accurate data about borrowers and properties.

The accord resolves "substantially all potential future repurchase claims" with Fannie Mae, Jane Fraser, head of the lender's mortgage unit, said in the statement. The bank will focus on producing "high-quality mortgage loans," said Fraser, named by Chief Executive Officer Michael Corbat to run the operation in May.

Citigroup shares gained 2.3 percent to $49.09 at 10:39 a.m. in New York. The 24-company KBW Bank Index rose 1.8 percent.

"The settlement is definitely a positive step" for banks facing such claims, said Kevin Barker, an analyst for Washington-based Compass Point Research & Trading LLC. Lenders need to bring down costs, and the more these claims are put to rest, "the less overhang there'll be on the stocks," he said.

The deal doesn't release Citigroup from liability tied to servicing the loans. The agreement also excludes a group of fewer than 12,000 loans made from 2000 to 2012, the bank said. These loans were sold with "certain characteristics" such as performance guarantees or under special credit enhancement programs, the company said.

Citigroup had set aside $1.42 billion at the end of March to cover demands to buy back bad mortgages, according to an April 15 presentation. The bank didn't say how much of those were tied to Fannie Mae.

Litigation and repurchases tied to defective mortgages have cost Citigroup more than $4 billion since 2007, according to data compiled by Bloomberg. Charlotte, North Carolina-based Bank of America, ranked second by assets, agreed to an $11.7 billion settlement with Fannie Mae in January.

Corbat, who replaced Vikram Pandit as CEO in October, is grappling with the costs of the bank's soured mortgage investments. The lender has sold about $10.6 billion of overdue residential first mortgages since the beginning of 2010 and has about $90 billion of home loans tagged for sale in the Citi Holdings division, according to a regulatory filing.

Regulators seized Fannie Mae and Freddie Mac — known as government-sponsored enterprises, or GSEs — in 2008 after their purchases of risky loans pushed them to the brink of collapse. The GSEs bought about $2.2 trillion of mortgages from the 15 biggest banks and Ally Financial Inc., according to Inside Mortgage Finance, a trade journal.

"Today's agreement resolves legacy repurchase issues, compensates taxpayers for losses, and allows Fannie Mae and Citi to move forward and strengthen our business relationship," Bradley Lerman, Fannie Mae's general counsel, said in an e-mailed statement.

Investors have renewed their interest in Fannie Mae and Freddie Mac as the firms post bigger profits amid a housing- market rebound. Fannie Mae had a record year in 2012, reporting net income of $17.2 billion for 2012, spurring speculation that the companies might repay their debt to taxpayers and exit government control.

Citigroup sold $293.7 billion of mortgages to the GSEs between 2005 and 2009, according to data provided by Compass. Fannie Mae bought $231.3 billion while Freddie Mac purchased $62.4 billion, the data show. Bank of America CEO Brian T. Moynihan has said his firm has paid the "lion's share" of its costs tied to defective mortgages. He has spent $19.1 billion to resolve repurchase demands, signing deals with GSEs, private investors and bond insurers, and set aside another $14.1 billion in reserves as of March 31.

About 80 percent of the firm's $17.1 billion in remaining claims are tied to private investors who weren't included in an $8.5 billion deal awaiting court approval.

Citigroup also faces demands for refunds from private investors. The bank had unresolved private claims tied to $2.4 billion of mortgages at the end of March, according to a presentation.

"That could be an even larger piece of the pie for Citi," Barker said.

Ally Financial, the Detroit-based auto lender whose mortgage unit filed for bankruptcy, agreed to pay about $462 million to Fannie Mae in December 2010 to resolve most claims tied to faulty mortgages, according to a statement. The accord released the company from liability linked to $84 billion in outstanding mortgage principal.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.